Chapter I FM
Chapter I FM
INTRODUCTION:
NATURE AND SCOPE OF
Financial managment
1
Definitions
J.F. Bradley :-“financial management is the area of business
management devoted to a judicious use of capital and a
careful selection of sources of capital in order to enable a
business firm to move in the direction of reaching its goals
Guttmann and Douglas:-” business finance can be broadly
defined as the activity concerned with the planning, raising,
controlling and administering the funds used in the
business”.
Financial Management: is concerned with the efficient
acquisition and deployment of both short and long term
financial resources, to ensure that the objectives of the
enterprise are achieved.
2
Financial Management
FM is the management of the source and
use of funds in an organization to help it
achieve its objectives.
Sources of funds: Debt vs Equity
Use of funds: Assets (both real and
financial)
3
Financial Management Decisions
Investment decision – both long term investment in non-
current assets and short term investment in working capital
5
Scope of financial management.
1.Estimating financial requirements
2.Deciding capital structure
3.Selecting source of finance
4.Selecting pattern of investment
5.Cash management
6.Profit management
7.Ensuring liquidity
8. Meeting statutory requirements.
6
Scope of FM
Finance is used by individuals (personal finance), by
governments (public finance), by businesses (
corporate finance) and by a wide variety of other
organizations, including schools and non-profit
organizations.
In general, the goals of each of the above activities are
achieved through the use of appropriate financial instruments
and methodologies, with consideration to their institutional
setting.
So the scope of FM is so broad that it applies in any
organization be it government, NGO, or business.
7
Objectives of Financial Management
1) Profit Maximization
2)Wealth Maximization
8
1. Profit Maximization
a. This is not a very precise objective.
Short run Vs Long run ambiguities.
More to the point, this goal doesn't tell us the
appropriate trade-off between current and future
profits.
b. It ignores:
Time value of money
Risk associated with returns
Benefits to owners
9
2) Wealth maximization
Wealth maximization means maximizing
share/stock holders wealth by maximizing the
current price of their share.
symbolically
10
Factors that affect price of a stock
11
1.13
The Agency Problem
Agency relationship
Principal hires an agent to represent their interests
Stockholders (principals) hire managers (agents) to run the
company
Agency problem
Conflicts of interest can exist between the principal and the agent
Agency costs
Direct agency costs – the purchase of something for
management that can’t be justified from a risk-return
standpoint, monitoring costs.
Indirect agency costs – management’s tendency to
forgo risky or expensive projects that could be justified
12
from a risk-return standpoint.
1.14
Managing Managers
Managerial compensation
Incentives can be used to align management
and stockholder interests
The incentives need to be structured carefully
to make sure that they achieve their goal
Corporate control (hostile takeover)
The threat of a takeover may result in better
management
Proxy fight (threat of firing)
Conflicts with other stakeholders
13
1.16 What is the role of financial markets in corporate
finance?
14
Financial Markets and institutions
Financial markets are markets for financial
instruments, also called financial claims or securities.
Places where financial instruments are purchased
and sold
Financial institutions (also called financial
intermediaries) facilitate flows of funds from savers to
borrowers.
15
Exhibit 1.1 – Transfer of Funds
16
Financial market and Institution …
17
Indirect Financing (“Financial
Intermediation”):
Financial intermediaries “transform” claims:
raise funds by issuing claims to SSUs;
use funds to buy claims issued by DSUs.
In the process:
SSU has claim against intermediary;
Intermediary has claim against DSU.
18
Primary and Secondary Markets
Primary markets are where financial claims are “born”:
DSUs receive funds, claims are first issued.
Secondary markets are where financial claims “live”—
claims are resold and re-priced.
Claims become more liquid
Trading sets prices and yields of widely
held securities
19
Money and Capital Markets
20
Money Markets
Help participants adjust liquidity—
Borrow money for short-term to fund current
operations
Lend money for short-term to avoid holding idle
cash
Common characteristics of money market
instruments—
Short maturities (usually 90 days or less)
High liquidity (active secondary markets)
Low risk (and consequently low yield)
21
Examples of Major Money Market Instruments
Treasury Bills
Negotiable Certificates of Deposit
Commercial Paper
22
Capital Markets
Help participants build wealth
Provides long-term financing for capital projects
Generate highest possible return for investors
Differences from money markets—
Long maturities (5 to 30 years)
Less liquidity
Higher risk in most cases
Examples for capital market instruments are Common
stock, Preferred stocks and bonds
23
1.20
Quick Quiz
What are the three types of financial management
decisions and what questions are they designed to
answer?
What are the three major forms of business
organization?
What is the goal of financial management?
What are agency problems and why do they exist
within a corporation?
What is the difference between a primary market and a
secondary market?
24
1.21
Summary 1.9
You should know:
The advantages and disadvantages between a sole
proprietorship, partnership and corporation
The primary goal of the firm
What an agency relationship and cost are
The role of financial markets
25
Financial Goals of the Corporation
The primary financial goal is shareholder
wealth maximization, which translates to
maximizing stock price.
Do firms have any responsibilities to
society at large?
Is stock price maximization good or bad for
society?
Should firms behave ethically?
26
THANK YOU…..
27